Strengthening health care’s supply chain: A five-step plan

The manufacturing of pharmaceuticals and medical devices is becoming increasingly complex. Companies are expanding their product portfolios to meet rapidly changing markets and lengthening product life cycles. Emerging economies want more affordable products. Quality and compliance issues are rising because products are more complex and regulatory scrutiny is stricter. And the number of drug recalls is increasing. Yet the supply chain remains fragmented and incomplete, with weaknesses that put patients at risk, cost billions in value, and lessen the health-care sector’s ability to take on the challenges it faces. (For more, see our video interview with McKinsey director Katy George on how improving the health-care supply chain will benefit companies across the industry.)

Video – click to view

Rethinking health-care supply chains

The good news is that models do exist to strengthen and improve the health-care supply chain. We believe that by learning from the experience of industries such as fast-moving consumer goods (FMCG), the health-care sector could cut production lead times and obsolescence, while manufacturers, distributors, hospitals, and pharmacies could carry significantly smaller inventories (Exhibit 1). Improving the health-care supply chain also could give millions of people around the world access to safer and more affordable health care, reduce costs, and provide new revenue sources for manufacturers.

Exhibit 1

Operational metrics suggest huge opportunities

Our research identified five specific capabilities that can have a dramatic impact on performance and bottom lines:

better segmentation of products, markets, and customers

greater agility, to reduce costs and increase flexibility

measurement and benchmarking

alignment with global standards

collaboration across the health-care value chain

Now, we recognize that transforming supply chains isn’t easy. In our experience, limited improvement efforts yield poor results, while comprehensive, integrated efforts are complex. But the payoff can be significant. Supply chains now account for nearly 25 percent of pharmaceutical costs and more than 40 percent of medical-device costs. The annual spending is so vast—about $230 billion on pharmaceuticals and $122 billion on devices—that even minor efficiency gains could free up billions of dollars for investments elsewhere. In fact, if the sector adopted straightforward advances well established in other industries, we estimate that total costs (from the supply chain and external areas, such as patient care) could fall by $130 billion.

Industry research, together with our own experience serving clients, has revealed opportunities to boost profitability throughout the value chain. The improvement from better-performing supply chains would range from about 6 percent for retailers to 20 percent for hospitals and producers of devices and medical supplies (Exhibit 2).

Exhibit 2

Opportunities from the transformation of supply chains can be found across the whole value chain

Easing shortages, improving safety

The cost of the shortcomings of today’s supply chain is substantial. Since 2005, drug shortages have nearly tripled in the United States and added more than half a billion dollars in costs for hospitals worldwide. Supply issues also create opportunities for counterfeiters and gray-market vendors, threatening patient safety and cutting into the revenues of legitimate companies. Supply-chain security breaches are increasing by an average of more than 33 percent every year, rising not only in emerging markets such as China, India, and Brazil but also in the developed world.

In addition, medication errors in the developed world occur in roughly 10 to 20 percent of all inpatient hospital admissions. About 1 in 10,000 patients admitted dies from adverse drug events, which, we estimate, add $20 billion to $90 billion in costs to the health-care system globally. Better supply-chain processes are central to increasing patient safety. We estimate that adopting a common global data standard and upgrading supply-chain processes could slash counterfeiting in half, returning $15 billion to $30 billion in revenue (by 2016) to legitimate companies for reinvestment in further improvements to patient care.

Building a new health-care supply chain

A typical Asian laptop manufacturer can accept an order on a Monday and deliver a pallet of freshly assembled customized computers to a European customer little more than a week later. In contrast, a typical pharmaceutical manufacturer has a lead time of about 75 days. How can medical-device and pharmaceutical manufacturers close the gap? Of the five comprehensive transformations we have identified, three can be accomplished internally. Two others—alignment and collaboration—are potentially the most powerful but require a company to work together with its customers, suppliers, and even competitors. Here’s what must be done.

Internal factors

1. Segmentation. Many pharmaceutical and medical-device companies come close to running one-size-fits-all supply chains. In practice, however, there can be significant differences in profitability, value per unit of weight, demand, the importance of a drug or device to patients, a customer’s cost to serve, and service expectations. Forcing products with such varied characteristics through a single set of supply-chain processes creates multiple inefficiencies, such as high inventories for some products while others are in short supply, the use of expensive air freight when slower surface modes would do, or a need to reschedule production campaigns hastily to meet urgent delivery requirements. Leading companies tackle these problems by intelligently segmenting their supply chains according to the characteristics of products and the requirements of customers. They then develop forecasting, production, and distribution strategies for each category.

2. Agility. This means more than just being fast when there’s an emergency; it means building an operating model that can better respond to demand shifts and customer wishes—at the same or even reduced cost. As we mentioned, the replenishment lead time from pharmaceutical plants to distribution centers is 75 days, on average. But leading companies in sectors such as fast-moving consumer goods take a fraction of that time, often without additional investments. Companies must better align the production cycle with the patterns of patient demand and increase the low frequency of their manufacturing processes. The average stock-keeping unit (SKU) is packaged every two to three months; only about 10 percent are packaged every two weeks or less.

An agile supply-chain model also requires stability in production, replenishment, and visibility. Many health-care companies need to make deliveries from third parties and in-house plants more reliable and to upgrade their sales- and operations-planning capabilities to the standards of the fast-moving-consumer-goods industry. The necessary improvements include a more disciplined cross-functional process, a better understanding of demand-and-supply scenarios and of underlying assumptions, more effective communication, and transparency on potential supply issues and bottlenecks.

3. Measurement. Health-care companies need to increase the transparency of their costs, including manufacturing, transport, warehousing, inventory holding, staff, and obsolescence—moves that could cut operational costs and optimize route-to-market approaches and product portfolios. Improvements are also needed in structural drivers or capabilities: responsiveness, manufacturing frequency, reliability of supply, and stability are mostly not systematically measured or managed across the network. Consumer-goods companies are clearly more advanced: they watch metrics such as the manufacturing-frequency index to measure the share of SKUs that are produced with high frequency. Finally, companies must standardize metrics across countries and plants. Commercially available benchmarking tools and approaches provide rough guidance for high-level opportunities in services, costs, and inventories, but not fully comparable results or tangible recommendations on how to capture value.

External factors

While internal optimization can deliver better service at lower cost, companies have even more to gain from optimizing externally. To do so, they must align processes and improve collaboration.

4. Alignment. Manufacturers of fast-moving consumer goods use point-of-sale information from retail customers to build production plans. The grocery industry, for example, has created billions of dollars in value by adopting standard barcodes. To build a cost-effective supply chain, the health-care sector could align around a single set of global standards that support data interchange, processes, and capabilities. Doing so may increase efficiency and patient safety by making it harder for counterfeiters to operate, by reducing medication errors, and by improving recall processes.

5. Collaboration. While the use of common standards is part of the challenge, supply-chain partners must find ways to collaborate more effectively to reap the full benefit. Barriers to improvement are often cultural rather than technical—transactional relationships must be transformed into something more ambitious. In our experience observing successful collaboration projects, six essential steps can make the difference between a productive collaboration and a frustrating one: companies must collaborate in areas where they have a solid footing; agree on sophisticated benefit-sharing models; select partners for the potential value of the collaboration, as well as their capabilities and willingness to act as a team; dedicate resources to the collaboration and involve senior leadership in it; jointly manage performance and measure impact; and start out with a long-term perspective.

At a recent meeting of senior supply-chain executives in the pharmaceutical and medical-device industries, we asked attendees which of these five supply-chain changes offered the greatest opportunity. More than 70 percent specified improved collaboration.

Transforming the health-care supply chain can do much more than improve the bottom line. By embracing the challenge of supply-chain leadership, pharmaceutical and medical-device companies can provide safer, more affordable access to products that enhance or even save the lives of people across the world.

Fourteen US and Canadian cancer institutes will use International Business Machines Corp.’s Watson computer system to choose therapies based on a tumor’s genetic fingerprints, the company said on Tuesday, the latest step toward bringing personalized cancer treatments to more patients.

Oncology is the first specialty where matching therapy to DNA has improved outcomes for some patients, inspiring the “precision medicine initiative” President Barack Obama announced in January.

But it can take weeks to identify drugs targeting cancer-causing mutations. Watson can do it in minutes and has in its database the findings of scientific papers and clinical trials on particular cancers and potential therapies.

Faced with such a data deluge, “the solution is going to be Watson or something like it,” said oncologist Norman Sharpless of the University of North Carolina Lineberger Cancer Center. “Humans alone can’t do it.”

IBM is positioning Watson for exactly this task: an area of medicine where humans can see the vast potential, but can’t begin to wrangle the data needed to achieve it. “Genomics is the secret to unlocking personalized medicine,” said Steve Gold, a Vice President of the IBM Watson Group, at a press conference on Tuesday.

Yet it is unclear how many patients will be helped by such a “big data” approach. For one thing, in many common cancers old-line chemotherapy and radiation will remain the standard of care, and genomic analysis may not make a difference.

The scientists directly involved with Watson aren’t making any promises, but they’re hopeful they can slowly begin to make a difference in the world of cancer treatment, which today leaves a great number of patients without many good options.

“Traditional cancer treatments are moderately effective, associated with moderate toxicity, and many patients still succumb to the disease,” said Lukas Wartman, assistant director of Cancer Genomics at Washington University and a leukemia survivor, at Tuesday’s press conference. “There’s been a lot of pessimism among those [fighting] cancer, and Watson offers an opportunity to fight back against that pessimism.”

Cloud-based Watson will be used at the centers – including Cleveland Clinic, Fred & Pamela Buffett Cancer Center in Omaha and Yale Cancer Center – by late 2015, said Steve Harvey, vice president of IBM Watson Health. The centers pay a subscription fee, which IBM did not disclose.

Oncologists will upload the DNA fingerprint of a patient’s tumor, which indicates which genes are mutated and possibly driving the malignancy. Watson, recognized broadly for beating two champions of the game show Jeopardy! in 2011, will sift through thousands of mutations and try to identify which is driving the tumor, and therefore what a drug must target.

Distinguishing driver mutations from others is a huge challenge. IBM spent more than a year developing a scoring system so Watson can do that, since targeting non-driver mutations would not help.

“Watson will look for actionable targets,” Harvey said, matching them to approved and experimental cancer drugs and even non-cancer drugs (if Watson decides the latter interfere with a biological pathway driving a malignancy).

But Watson has trouble identifying actionable targets in cancers with many mutations. Although genetic profiling is standard in melanoma and some lung cancers, where drugs such as Zelboraf from the Genentech unit of Roche Holding AG target the driver mutation, in most common tumors traditional chemotherapy and radiation remain the standard of care.

“When institutions do genetic sequencing, only about half the cases come back with something actionable,” Harvey said, often because it is impossible to identify the driver mutation or no targeted therapy exists.

The other collaborating centers are Ann & Robert H. Lurie Children’s Hospital of Chicago; BC Cancer Agency in British Columbia; City of Hope, in Duarte, California; Duke Cancer Institute in North Carolina; McDonnell Genome Institute at Washington University in St. Louis; New York Genome Center, Sanford Health in South Dakota; University of Kansas Cancer Center; University of Southern California Norris Comprehensive Cancer Center, and University of Washington Medical Center.

A new bipartisan committee’s working group will gather on Capitol Hill throughout the coming months to find ways to improve electronic health records, according to Senate health committee chairman Lamar Alexander (R-Tenn.) and ranking member Patty Murray (D-Wash.).

The group will work to find five or six ways to “make the failed promise of electronic health records something that physicians and providers look forward to instead of something they endure,” Murray said in an announcement.

All members of the Senate health committee are invited to be a part of the working group. Staff meetings begin this week, with participation from health IT professionals, industry experts and government agencies.

The working group’s goals include the following:

Help providers improve quality of care and patient safety.

Facilitate interoperability between EHR vendors.

Empower patients to engage in their own care through access to their health data.

Protect privacy and security of health information.

The working group isn’t the only way Alexander and Murray are pushing for change when it comes to EHRs.

The Government Accountability Office placed the Veterans Affairs Department’s healthcare system on a list of high-risk programs for 2015, saying at an April 29 Senate Veterans’ Affairs Committee hearing that the agency needs to address inadequate oversight and ambiguous policies.

“Risks to the timeliness, costeffectiveness, quality and safety of veterans’ healthcare, along with other persistent weaknesses GAO and others have identified in recent years, raised serious concerns about VA’s management and oversight of its healthcare system,” said GAO Healthcare Director Debra Draper at the hearing.

GAO prepared testimony (pdf) says VA operates one of the largest healthcare delivery systems in the nation, including 150 medical centers and more than 800 community-based outpatient clinics.

Enrollment in the VA healthcare system has grown significantly, increasing from 6.8 to 8.9 million veterans between fiscal years 2002 and 2013, GAO says.

Over this same period, Congress has provided steady increases in VA’s healthcare budget, increasing from $23.0 billion to $55.5 billion.

At the hearing Draper outlined five major areas that put the VA at risk of failing to provide adequate healthcare to veterans including ambiguous policies and inconsistent processes, inadequate oversight and accountability, information technology challenges, inadequate training for VA staff and unclear resource needs and allocation priorities.

John Daigh, the VA’s assistant inspector general, agreed with Draper’s assessment of the Veterans Health Administration.

“VHA is at risk of not performing its mission as the result of several intersecting factors,” Deigh said. “VHA has several missions, and too often management decisions compromise the most important mission of providing veterans with quality healthcare.”

Daigh focused on the Veterans Integrated Service Networks – regional offices that are set up to oversees VA medical centers in certain areas – saying the current VISN structure has not worked effectively to support and solve problems facing hospitals.

One role of the VISNs is to make sure medical providers at each facility are doing their job properly with periodic reviews.

Daigh said in prepared testimony (pdf) that a forthcoming VA OIG report found that in hospitals where there are specialty units with small numbers of providers, it is difficult to obtain unbiased peer reviews of clinical cases and assessments of clinical performance by peers.

That lack of data makes it difficult for VISN’ to accurately assess medical care providers. But medical centers shouldn’t be shouldering all of the blame, Daigh said.

“The VISN structure has been inconsistently effective in addressing this issue,” he said.

Each VISN has a different internal organization and each medical facility has a different internal structure.

“This lack of standardization makes the dissemination of information and policy to facilities challenging and the acquisition of critical data from facilities more difficult,” Daigh said.

For more:
– go to the hearing page (webcast and prepared testimony available)

The association, which represents all 141 accredited U.S. medical schools and nearly 400 teaching hospitals, said first-year medical school enrollment will reach 21,304 in the 2019-20 school year. It’s just 130 positions short of a goal the association, known as the AAMC, called for in 2006 as one of the nation’s leading advocates to address a doctor shortage.

AAMC said more medical schools have opened while existing universities have expanded programs or tweaked curricula to get students interested in certain medical disciplines. For example, 72% of medical schools told AAMC they were planning “at least one initiative” to increase interest in primary care specialties.

Primary care professions of all kinds are needed as insurance companies and government health programs like Medicare and Medicaid emphasize paying for value over reimbursing doctors for volume of tests and procedures in the traditional fee-for-service medicine. Insurers like Aetna (AET), Anthem (ANTM), Cigna (CI), Humana (HUM) and UnitedHealth Group (UNH) reported in their first quarter earnings that they are ramping up payments for care coordination, which emphasizes primary care and outreach to patients.

Though the interest in becoming a doctor somewhat addresses a physician shortage, it doesn’t solve the problem. After medical school, these potential future graduates still have to enter a residency program.

And with residencies funded by the Medicare health insurance program for the elderly, it would take an act of Congress to increase the number of slots.

“Without an increase in federally funded residency training positions, all these new medical school graduates may not be able to complete their training and become practicing physicians,” said Dr. Darrell Kirch, AAMC’s president and chief executive said in a statement accompanying the report.

Should drug makers be required to disclose their costs to justify rising prices?

This is what a growing number of state legislatures are considering. Over the past several weeks, lawmakers in a handful of states stretching from California to Massachusetts have introduced bills in a bid to force the pharmaceutical industry to conduct an economic striptease.

“We need to have some transparency,” says Tony DeLuca, a Democrat who chairs the Pennsylvania House Insurance Committee and who introduced one such bill earlier this week. “Some of the sticker prices are outrageous. I’m hoping it achieves lower health care costs.”

The bills are not wholly identical. Some would require drug makers to report profits and various operational costs for any medicine that has a price tag of more than $10,000 a year, while others seek this information for all medicines, regardless of price. A bill was also introduced in North Carolina.

The effort comes as a national debate intensifies over prices for prescription medicines. Over the past year, payers – both public and private – have remonstrated over the cost of new specialty drugs for hard-to-treat ailments and for older generic drugs that were supposed to offer low-cost alternatives.

A new poll by the Kaiser Family Foundation found that 76% of Americans overall – and across party lines – say their top health care priority is ensuring that high-cost drugs for chronic conditions, such as HIV, hepatitis, mental illness and cancer, are affordable.

The issue is placing drug makers on the defensive, even as they argue pricey new medicines – notably, those for combating hepatitis C and certain rare diseases – represent good value for illnesses that would, otherwise, cost more to treat in the long run.

These bills represent a new front, though, in trying to blunt escalating price tags. And the legislation is winning enthusiastic backing from business groups, consumers advocates and health insurers, which some legislators say have helped craft language.

“This is about starting a conversation,” says Charles Bacchi, chief executive at the California Association Plans, which worked with a California legislator on one bill. “We need real answers about why these drugs are priced so high. Yes, there are limits to what a state can do, but it’s a debate we need to have.”

To what extent these bills may succeed is uncertain, at best.

Drug makers, not surprisingly, are pushing back and recently helped defeat legislation in Oregon. Earlier this week, the pharmaceutical industry trade group testified against the bill in California, where a vote was postponed until next week in light of opposition, according to a legislative aide.

As far as drug makers are concerned, the bills are not only onerous, but make demands they maintain cannot be met. For instance, an industry trade group argues that providing development costs for some drugs may be impossible when research was simultaneously conducted on other medicines that failed. The bottom line, says the California Healthcare Institute, is that the bill would “stifle innovation.”

“The price charged for an individual drug is not a reflection of development costs,” says Ken Kaitin, director of the Tufts Center for the Study of Drug Development, which receives pharmaceutical industry backing. “Pricing strategies are based on therapeutic value, market size, usage, patent life, competition and other factors.”

Even if one or more bills were to become law, there is no certain path toward lowering prices. But the effort may resonate around the country, especially with the 2016 presidential campaign under way. “This may be a model that other governments may want to build upon,” says Jamie Love of Knowledge Ecology International, a non-profit group that tracks access to medicines issues.

“While it is too soon to know if this prescription transparency legislation will continue to expand this year,” says Richard Cauchi, the program director for health insurance, financing and pharmaceuticals at the National Conference of State Legislatures, “state legislators often do look at what their colleagues in other states are doing.”